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There is a fundamental issue that I do not understand with the question below. I know how to get the answer and method invloved, but what I do not understand is the concept behind it.
At 31 December 2004 Q, a limited liability compnay owned a building that cost 800,000 on 1 January 1995. It was being depreciated at 2% per year
On January 1 2005 a revaluation to 1,000,000 was recognised. At this date the building had a remaining useful life of 40 years
What is the depreciation charge for the year ended 31 december 2005 and the revaluation reserve balance as at 1 Jan 2005?
Depreciation charge revaluation reserve at 1 jan 2005
a. 25000 200,000
b. 25000 360,000
c. 20000 200,000
d. 20000 360,000The answer is as follows
1,000,000 / 40 years = 25000;
1,000,000 – (800,000- (800000*2%*10 years)) = 360,000
so the answer is B
N.B.
Now what I do not understand is that ok now the building is worth 1,000,000, hence it needs to be depreciated, so new depcreciation rate is 25,000 p.a for 40 years which will bring it to 0 at end of life. But what about the 160,000 that has already been depreciated and expensed from 1995-2004??building usually have 50 years of useful life.
800,000*2%*10 years=160,000
800,0000 revaluation 1000,000=200,000
dr cost cr revaluation=200,000
dr accumlated depreciation cr revaluation=160,000
dr depreciation=1000,000/40=25,000-current year depreciationHi,
The $160,000 of depreciation has already played its roll in deciding the amout of ‘revaluation reserve’. After deducting $160,000 from the original cost of $800,000, we arrived at $640,000 and thus credited our revaluation reserve by $360,000 and not $200,000.
Regards
@heezay said:
But what about the 160,000 that has already been depreciated and expensed from 1995-2004??simply, when you are going to record the result of the revaluation, you have to throw out the old accounts of the revalued assets, so after revaluation you don’t have the depreciation of prior period.
good luck
Just to clarify people this is not a question about how to do depreciation, I know how to do it.My question is abit more in depth if you’d like. Let me put it in another way that may help understand.
Cost : 800,000
Depreciation: 2% p.a @ 10 years
800,000/50 = 16000 x 10 years = 160,000“Now up until 10 years can you see we have already expensed 160,000”
Revaluation: 1,000,000
Depreciation:
1,000,000/40 = 25000 x 40 = 1,000,000Now remember here we have also expensed another 1,000,000 over 40 years,
Now this is my question if an asset value remained constant at 1,000,000 till the end of life, in total 1,160,000 would have been expensed because of the revaluation and not the value of 1,000,000, so what happened to the 160,000 we expensed? Do we get it back when its sold or something?
10 years depreciation @ 800,000/50 x 10 = 160,000
40 years depreciation @ 1,000,000/40 x 40 = 1,000,000Sorry if this is more confusing, its just a specific question in my head I do not understand as more than the value of the asset would have been expensed in total??
please pay attention to this clue that the new value of 1,000,000 is the asset’s value in the revaluation date, it means that this value is not the asset’s value for whole its life ( 50 years ) this value is just for 40 years remaining life, it means that the asset had a value for the business more than 1,000,000.
in fact, this asset is expected to has a value of 1,000,000 for the next 40 years of its life but what about its first 10 years of life ? yes, we used it in the last 10 years up to 160,000 and we will use it later up to 1,000,000, therefor we will totally have 1,160,000 expense.please feel free to keep on this topic if you need
good luck800,000*`10 years*2%=160,000-1st 10 years depreciation
from 800,000 to 1000,000=200,000dr cost 200,000
dr acc depreciaton 160,000
cr revaluation 360,0001000,000/40 years=25,000 per year depreciation-2005 current year depreciation
@choonfah87 said:
800,000*`10 years*2%=160,000-1st 10 years depreciation
from 800,000 to 1000,000=200,000dr cost 200,000
dr acc depreciaton 160,000
cr revaluation 360,0001000,000/40 years=25,000 per year depreciation-2005 current year depreciation
Dear choonfah
firstly. thank you for your post but Heezay said that there is not any problems about calculation, he/she had some conceptual problem.
good luck
@mahdiniaacc said:
please pay attention to this clue that the new value of 1,000,000 is the asset’s value in the revaluation date, it means that this value is not the asset’s value for whole its life ( 50 years ) this value is just for 40 years remaining life, it means that the asset had a value for the business more than 1,000,000.
in fact, this asset is expected to has a value of 1,000,000 for the next 40 years of its life but what about its first 10 years of life ? yes, we used it in the last 10 years up to 160,000 and we will use it later up to 1,000,000, therefor we will totally have 1,160,000 expense.please feel free to keep on this topic if you need
good luckYou have definetly come the closest to understanding what my issue is here and clarified one point that 1,160,000 is actually expensed and 160,000 is not recovered at any point. If this is the case this brings me to another point which I will list out.
1 – If this is the case, (for example a start up company) when making their decisions (in times of rising prices) on policies to set in place does this not force them to prevent the idea of revaluation to show a true reflection of their assets as this is likely to cause an additional expense which can be avoided by not revaluing? Surely in times of rising prices including a revaluation every year, can create a gradually accumilating additional expense, which might and likely to put off companies revaluing? As profits are likely to be stated higher?
2 – Is it and how would it be fair to have charged the business more than what the asset is worth?
3 – Working the opposite way, a reduction of 60% in the assets original valuation would create an income?
4 – The only fairest method that comes to my mind would be.
Valuation or Revaluation – Depreciation to date = Outstanding amount to be depreciated/”divided” by the number of years remaining. This way no additional expense or income is being created at any point and at any given time only the assets value will ever be absorbed?But of course according to books I understand this way of thinking is completly wrong. Can not seem to justify it in my head??
I think u have not still understood the core of the revaluation method that given in the question but it’s clear that u got the main core of its concept.
yes, your statement in the fourth paragraph is absolutely true but u have to know that the question which u gave it at first, is based on your statement. however. this thinking is not true that with the revaluation the business will expense more than the asset’s registered value.
please assume that you are going to revalue an asset with the NBV of $640,000 and 40 years remaining life. the valuer tried to find the fair value of the asset and finally decide to compare the asset with a new equal asset’s value of $1,250,000 with 50 years useful life. So we know that the new asset’s remaining useful life is not equal to the old asset’s remaining life. in this manner the valuer has to compute the depreciated replacement value of the new asset then compare it with the old asset’s NBV. now we have $1,000,000 as the new asset’s NBV as its depreciated replacement value for 40 years useful life.now is it clear that this $1,000,000 is not the whole of the old asset’s useful life (50 years )?
the key point that you have not gotten it is that the $1,000,000 is the replacement value of the new asset in the date of revaluation not the old asset’s all useful life.
In fact, we used the first 10 years of the old asset’s useful life so it’s a separate expenses and we will use the next 40 years of its useful life as another separate expenses.good luck
Hi Heezay
Good question – and how frustrating that no one has picked up on your real query. Let me try.
You are absolutely correct that there will be a total of 1,160,000 depn charged on this asset over its life and retained earnings ( ret ears ) will be correspondingly reduced by this amount, even though the asset only cost 800,000 and was revalued to 1,000,000. The “missing 160,000” as you know is in the revaluation reserve.
It’s not an F3 point – more a point for F7 – and even then, what I’m about to tell you is not mandatory – just recognised as “good practice” Continued in next post
Each year’s income statement will be being reduced by 25,000 – the new depreciation – whereas previously it was reduced by only 16,000 – 2% x 800,000. So profits are being artificially reduced by an additional 9,000 each year. Over 40 years, that’s 360,000 ie the same figure as in the rev res.
The 360,000 credited to rev res MAY ( good practice ) be released to ret ears at the rate of 9,000 through Statement of Comprehensive Income and therefore also by way of transfer between reserves in the Statement of Changes in Equity.
So ret ears are compensated each year by 9,000 and over 40 years the rev res is recognised as a realised profit.
Interestingly, this also touches on a (tiny) part of the F4 law syllabus and may ( I don’t know for sure ) touch on the F6 tax syllabus – tax is not one of my subjects, that’s why I’m not sure
@ Mike
With due respect, I don’t think you have added much insight into the already solved mystery. There has been no ‘missing 160,000’ from the beginning.
In my first post (https://opentuition.com/groups/f3-financial-accounting/forum/topic/question-on-depreciation-and-revaluation/?_wpnonce=c7e3d9aa5f#post-48534) I just said that the 160,000, with its allocation being the core of Cheezah’s problem, had already played its role in deciding the amount of ‘revaluation reserve’. Let us review it again:
If we had not been reducing the annual depreciation of 16,000 from the value of building from our books, then at the time of revaluation we would have valued our asset at 800,000, right?
In such a case, our revaluation reserve might have been:
1,000,000 – 800,000 = 200,000
But since our value had been being depreciated at 16,000 per year, then the NBV of our asset was just 800,000 – 160,000 = 640,000, thus we creadited our revaluation reserve by an additional 160,000 up to 360,000. In other words, that 160,000 didn’t vanish into air, but actually contributed to our revaluation reserve being enriched.
So the problem of our expenses equalling 1,160,000 is also solved. We had paid 800,000 to aquire the asset, true, but why are we forgetting the fact that by paying just 800,000, we had also a revaluation reserve of 360,000 as well?
So:
800,000 + 360,000 = 1,000,000 + 160,000 = 1,160,000
Regards
I quote “But what about the 160,000 that has already been depreciated and expensed from 1995-2004??” If that’s not asking about a missing 160,000, then I’m a Dutchman!
But, if we are all happy, then let’s leave it at that.
My last post was all about that 160,000 expensed in that 10 year period.
Regards,
Dear Mike
Your explain about the accounting of the difference between depreciation based on the historical cost and depreciation based on the revalued amount of the asset is completely true and it’s according to the IAS 16 :
Quote:International Accounting Standard 16
Property, Plant and Equipment
41 – The revaluation surplus included in equity in respect of an item of property, plant and equipment may be transferred directly to retained earnings when the asset is derecognised. This may involve transferring the whole of the surplus when the asset is retired or disposed of. However, some of the surplus may be transferred as the asset is used by an entity. In such a case, the amount of the surplus transferred would be the difference between depreciation based on the revalued carrying amount of the asset and depreciation based on the asset’s original cost. Transfers from revaluation surplus to retained earnings are not made through profit or loss.However, as far as I understood from Heezay’s question and his/her further explanation, this is not the main point of his/her problem because you kindly explained about difference of 9,000 but Heezay’s problem is about prior expense of 160,000.
I think Heezay misunderstood that the depreciable amount of the asset for next 40 years should be 840,000 ( 1,000,000 – 160,000 ) while, as I said before, this 1,000,000 is the asset’s value for its next 40 years useful life not its 50 years useful life. Even, if we assume that this 1,000,000 is the asset’s 50 years useful life so its 40 years equivalent useful life value should be 800,000 ( 1,000,000 * 40 / 50 ) – ie depreciated replacement value.thank you for your attention.
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